February 2009 prem 4 Africa Region

Recommendations⁵

13. 
    Monetary policy should continue being oriented toward further accumulation of foreign exchange reserves to consolidate the credibility of the peg. To that end, monetary authorities should continue managing liquidity actively through the appropriate issuance of short-term bills by the Central Bank. In addition, the Central Bank should continue closely monitoring interest rate differentials with the Euro area and USA to prevent declines in remittances.
    
14. 
    Fiscal policy should continue to be dominated by fiscal prudence, which will help create space to absorb potential shocks and preserve the low risk of debt distress. Authorities should continue building the budget on conservative estimates of projected revenues, which has helped prevent over-spending. Furthermore, the authorities should continue implementing measures to avoid the accumulation of arrears both at the levels of central government and municipalities.
    

2. Fiscal Performance

Trends and Composition of Revenue

1. 
   The share of total revenue to gross domestic product (GDP) for 2002–06 shows a stable trend, with some declines in 2003 and 2006.⁶ Total revenues as a percentage of GDP has decreased slightly from 32 percent in 2002 to approximately 30 percent in 2006 (table 2.2). It averaged 31 percent over the whole period. Despite the stable trend throughout the period, it declined approximately 4 percentage points in 2003 and 1.4 percentage points in 2006. Deterioration in revenue performance during these two years was due largely to a decrease in foreign aid and, in 2003 due also to a slowdown of fiscal revenue growth. Foreign aid represents, on average, 25 percent of total revenue, with minimums of 22 percent in 2003 and 19 percent in 2006. A slight increase in total revenue, expressed as a percentage of GDP, was anticipated for 2007 (from 30 percent in 2006 to almost 34 percent in 2007).
   
2. 
   Supported by two comprehensive reforms in indirect taxation introduced in early 2004 (tariff reforms and introduction of the VAT), tax revenue performance has been strong. Total fiscal revenues declined in 2003 (stood at 18.8 percentage of GDP) and increased steadily, averaging 21 percent after 2004. The steady revenue performance has been due largely to the introduction of VAT, which has substantially compensated the loss of the import tax and helped improve Cape Verde’s fiscal administration. Import tax revenues represented an average of 8.4 percent of GDP in 2002 and 2003 and decreased to 4.8 percent from 2004 through 2006. For 2007, they were expected to represent 5.2 percent of GDP. On the other hand, VAT represented, on average, 7.5 percent of GDP for 2004-06, whereas consumption taxes represented approximately 3 percent of GDP for 2002–03.
   
3. 
   Import tax revenues are expected to decline in the future due to revised custom taxes. In early 2004 the government implemented a radical fiscal reform that eliminated most of the taxes and contributions administered by Customs. The number of tariff brackets was reduced from 64 to 7, and the maximum tariff was leveled from 250 percent to at 50 percent. However, Cape Verde’s tariffs are still high, and in the context of WTO membership, tariffs were expected to be revised. On December 18, 2007, the WTO’s General Council approved a package of agreements that spells out the terms of Cape Verde’s accession. In this process, all remaining (tariff and nontariff) measures to protect local industry were abandoned. Furthermore, a new Customs Code was prepared and is expected to be approved by the National Assembly in 2008. This code will provide progressive liberalization of import rules and procedures.
   
4. 
   Collection of fiscal revenues improved and is expected to improve further as a result of additional reforms in the tax administration. The Enactment of Decree-Law No. 35/2003 brought about an improved recovery of fiscal arrears, since it endowed the General Directorate of Taxes (Direcção Geral de Contribuição e Impostos, or DGCI) with the power to affect compulsory collection through confiscation of assets and bank accounts. Additional improvements are expected through the introduction of the Fiscal Identification Number (FIN), which came into being in 2006 and is expected to render better management of taxpayer data. A project to automate revenue management and taxpayer current account management is being implemented as an instrument to increase the control and efficiency of tax collection. Reforms in tax administration also include the end of the agreement with Banco Comercial do Atlântico (BCA) as the sole tax collector and revision of legal texts (new IUR on corporate and individual tax, and stamps). Until 2006, BCA was the only tax collector and retained 1 percent of the taxes collected. During the first semester of 2006, agreements were signed with other institutions whereby a flat rate of 200–300 ECV per collection was defined as the remuneration for its services. BCA signed a similar agreement in May 2007, with retroactive effects dated July 2006. This has provided taxpayers with more payment options and is expected to reduce revenue forgone.
   
5. 
   Direct taxes represented, on average, 6.8 percent of GDP from 2002 to 2006 but are below their potential owing to the extended and unfounded system of fiscal exemptions and large fiscal evasion. Preliminary data for 2006 suggest that revenues lost to fiscal exemptions correspond to approximately 12 percent of fiscal revenues. There also is the belief that fiscal evasion is massive. The extended system of exemptions and the wide-ranging evasion contributes to the narrow and skewed nature of the taxpayer base. Approximately 15 corporations account for 66 percent of total tax revenues; one of them accounts for one-third of the total (corporations as a whole represent 44 percent of direct tax revenues). Therefore, to reduce the dependence on large taxpayers as a source of revenue, rationalization of exemptions and fiscal incentives is very important. The law is being drafted (there is already an inventory of the existing laws) and is expected to be submitted to Parliament in 2008.
   
6. 
   Recurrent revenues have shown an ascending trend, whereas capital revenues (consisting mainly of foreign aid) have shown annual fluctuations, highlighting the ever-present uncertainty attributable to this source of income. Foreign aid has undergone ups and downs from as low as 6 percent of GDP in 2003 and 2006, to 9 percent in 2002 and 2004. With Cape Verde’s graduation to the status of middle-income country, its eligibility for foreign aid and concessional funds is expected to decrease over time, making it even more important for the country to create fiscal space to respond to future pressures.
   
7. 
   Overall, total revenues projections have been close to revenues outturns. However, this closeness hides significant individual deviations. Nonfiscal revenues and foreign aid present great overestimation. (table 2.1). For example, in 2003 and 2005, the execution rate of foreign aid was approximately only 63 percent. This is not surprising. In Cape Verde, as in many other countries, aid projections, particularly for project financing, tend to be overly optimistic. On the other hand, revenues from VAT and international transactions have been often underestimated. The difficulties in making projections emerge from the lack of an adequate model. In this regard, staff from the Ministry of Finance and Public Administration are being trained to build capacity in financial programming.
   

2 Approved budget.

2 Approved budget.

2 Approved budget.

Table 2.9: Revenues, 2002–06

(executed revenues as % of budgeted revenues)

2 Approved budget.

Recommendations

• 
  Finalize the draft law on tax exemptions. Reduction of tax exemptions is important to increase VAT effectiveness, and to enlarge the narrow tax base, thus reducing the current dependency on a few companies. It also is recommended to unify all exemptions in the single law covering all fiscal incentives.
  
• 
  Develop a legal and strategic action framework to ensure operability of tax inspections and its link to other competent institutions involved in criminal research.
  
• 
  Develop and implement IT supporting projects, and programs for tax management inspection.
  
• 
  Reinforce inspections related to high risk tax-payers and critical areas.
  

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